Small Business

How Angel Investing Works

While VCs make much larger investments, angel groups give from around $25,000 to $50,000—and tend to want real involvement with the company

Is your company looking for an equity investment under a few million dollars? You might first think of approaching venture capitalists, but I suggest you try angel groups. For the most part, VCs manage large pools of money—sometimes in excess of $1 billion—and do not have the time to deal with many investments. They prefer to make large investments that range from $5 million to $10 million per transaction.

Angels, on the other hand, are wealthy individuals who invest funds in early-stage companies (BusinessWeek, 4/17/08). The amounts often range from $25,000 to $50,000 per deal. Over the past decade, angel investors have formed angel groups that meet either monthly or quarterly—and pool together their deal flow, resources, and capital.

You can find Web sites for angel groups across the country at the Angel Capital Association's Web site as well as through funding network Angelsoft. For a fee, you can pitch to angels directly via Angelsoft.

Because of the high risks, angels look for opportunities that have the potential for outsize returns, such as in the 10-times to 20-times range. Consider the criteria in my previous column, "How to Craft a Winning Investment Deck" (BusinessWeek.com, 8/1/08) to determine if your company would be a good fit for angel investment.

Local Interests

Be aware that angel groups tend to focus on local companies. A key reason is that angels usually want to be involved in the company, such as serving on the board. This help can be valuable in terms of building a sustainable company as well as finding the funders for the next round of capital or even a possible acquirer.

It's also good to keep in mind that an angel group may receive anywhere from five to 50 plans a month. The group's staff—usually several full-time employees—will weed out 85% or 90% of the companies that do not meet the criteria. The remaining 10% to 15% will probably be narrowed down to one or two companies after several rounds of presentations.

At this point, a member from the angel group will take the lead on a deal and round up investors. He or she will also help conduct the due diligence, which will include reference checks, competitive analysis, and a review of the intellectual property. This process can easily take a month.

A Tough Process

Along the way, the lead member will negotiate the term sheet. It will be a typical Series A document, which is also what VCs use for their first round of funding. This means you'll see terms like liquidation preferences, board seats, and anti-dilution clauses (BusinessWeek.com, 8/22/08).

Yes, it can be a tough process, and the odds of success are not good. In addition, as should be no surprise, the current market instability is adding to the difficulties. Angels are starting to focus on deals that have lower levels of risk. They are also likely to demand lower valuations and stronger terms. After all, with the low mergers and acquisitions and initial public offering activity (BusinessWeek.com, 7/9/08), it's taking much longer for angels to get returns on their investments.

So why go through all this trouble? You'll probably give up less equity than you would with a VC. And while VCs will provide some feedback, you are likely not to have to go through the same multipresentation process that you would with an angel group, which is invaluable experience for future fund-raising efforts. Besides, you might find some individual angels who invest in your company—even if the group does not.